Last Friday the Sterling closed at 1.094 to the Euro. Not only is it a remarkable figure for crossing below 1.1, it is the lowest weekly close since 2009. In effect, since the common currency was introduced to currency markets in 1993, the Sterling closed against it below this level only in eleven other weeks. They all took place between December of 2008 and October of 2009, at the height of the housing crisis, when European institutions failed to address financial markets with the haste seen in grown-up economies.

This brief note puts this monetary devaluation into a broader perspective, within the context of the UK's exit from the EU. Sterling is just a visible facet of an overall economic setting deteriorating in anticipation of the UK's shift into a new - and largely unknown - economic paradigm.

Front paged - Frank Schnittger

Unlike in 2008/2009, this time there is no economic crisis to justify the fall of the Sterling, much to the contrary, and the wild swings in exchange rates witnessed back then are now oddities. The weakness of the Sterling is not the product of market volatility, it is now a clear secular trend settling in. Since December of 2015, when the UK's House of Commons confirmed the referendum on EU membership, the Sterling lost 23% of its value against the Euro.

So far UK households have felt this devaluation primarily in rising prices of consumer goods. In a phenomenon popularly dubbed "Shrinkflation", consumers face a decrease in the quantities packaged of thousands of products, from chewing gum to toilet paper, even though prices remain as before.

But it is at the macro scale that the challenges posed by this devaluation are most visible. Inflation is rising considerably faster than wages (2.7% against 1.8%) eroding purchasing power; consumer spending falters and the UK is now among the slowest economies in the EU and the world. And when account in US Dollars or Euros, the UK's GDP is in clear decline.

There is though something even more worrying brewing: the trade deficit is still widening. A weaker currency would in normal circumstances mean a boost to exports and an improvement of the trade balance, but in this case rising imports have canceled out the effect. The secular trade deficit widening trend that set in after the peak of North Sea petroleum and gas extraction in 2000 remains intact. In consequence, private debt is surging relentlessly.

This state of affairs has greatly narrowed the range of monetary and economic policies available to the Bank of England and the Exchequer. Rising interest rates to tame inflation and support the Sterling would threaten the fragile economic growth and widen further the trade deficit. The status quo equates to continued Sterling weakness, loss of purchasing power, declining consumer spending and a billow of private debt. Institutions must now recur to the "imagination" so often referred in the context of Article 50 negotiations to develop their policies.

In his mid year press conference, the Governor of the Bank of England left some subtle references to the constrictor these trends are circling around the UK's economy:

Monetary policy cannot prevent the weaker real incomes likely to accompany the move to new trading arrangements with the EU. But it can influence how this hit to incomes is distributed between job losses and price rises, and it can support UK households and businesses as they adjust to such profound change.

Consumer credit has increased rapidly. Lending conditions in the mortgage market are becoming easier. And lenders may be placing undue weight on the recent performance of loans in benign conditions.

This is the Bank of England trying to square the circle.

One of the policies that could be tried at this time would be raising wages, possibly changing the minimum income legislation. This would not address the widening trade deficit and would put pressure on economic growth. The Bank of England could in its turn attempt to support the Sterling by using its foreign currency reserves, counted in the order of 160 G$. However there are some 380 G$ in gilts and other Sterling denominated debt instruments held overseas. If it ever comes to that, it will be an uneven fight. Moreover, the Bank of England can hold to its "jobs first" policy only for so long, if the Sterling comes to be perceived as a currency in demise a deluge of these foreign reserves may unfold. In such a scenario the Bank of England would effectively lose control over the Sterling.

This is just a prelude to the exit of the UK from the EU and the EEA. These trends shall remain in place, with Sterling-Euro parity a real possibility in the following six months. The UK government has just published its Article 50 negotiation position in a number of areas, sitting itself an ocean apart from what the EU is willing and legally able to accept. The first breakthroughs in these negotiations, initially expected to October, have already been postponed to Christmas. By next Spring various industries will be preparing their post exit offerings and business plans. The possibility of no concrete agreement being in place by then renders any economic predictions attempted now a futile exercise.

Good discussion. Coincidentally I have a diary up on the same topic written from a more Irish perspective. The main point is that Brexit has already been a disaster for the UK economy, with only a radical Sterling devaluation masking a huge decline in UK GDP, real incomes, and consumer spending. And yet pro-Brexit economists are still touting the UK's "growth" in Sterling terms and record employment as evidence that all is well...

David Davis has warned that the clock is ticking on Brexit - Professor Patrick Minford from Economists for Free Trade tells Channel 4 News that leaving the EU without a trade deal would bring a 135-billion-pound boost to the economy.

Yea that was the article i was referring to but couldn't find again when I was writing my comment above. If devaluation is such a wonderful boost to the economy, then they already have its benefits without ever having to leave the EU!

Devaluation also effectively imposes an import duty on imports by adding 18% to their price in Sterling terms. So far the response of CPI to this has been muted - barely rising to 2.6% but presumably this will increase further as the rising cost of imported goods feeds through the supply chain.

Historically most economists regard devaluation as a useful short-term safety valve to reduce the impact of an economic crisis and to facilitate faster recovery. However longer term its benefits erode as increased import costs feed into inflation and output prices.

What is perhaps more remarkable is the degree to which the UK economy has failed to respond to the stimulating effects of such a large devaluation which indicates their are structural problems in the UK economy which devaluation is only masking for the time being.

The other surprising thing is that foreign investors and creditors aren't pulling their assets out of Sterling more rapidly in response to such a massive loss of value. I would expect a massive Sterling crisis when they start to do so to a much larger extent.

A breakdown in Brexit negotiations could be the trigger for such an event posing even greater difficulties for EU exporters to the UK.

Increasingly the end of the A50 period can't come quickly enough for EU industries if it means they will become less exposed to low cost UK competition enabled by Sterling devaluation.

The devaluation is a defensible policy, in many situations a proper vehicle to protect common folk from economic shock. There is a world of difference between loosing 20% of your income and losing your job.

The problem here is the widening of the trade deficit at the same time. This means Sterling is not venting all the pressure building in the system.

Yes, devaluation s a sensible policy from the UK point of view, but from an Irish/EU perspective it risks devastating industries dependent on exporting to the UK or competing with UK exports in EU markets in a customs & tariff free environment. Tariffs, whether WTO or otherwise, cannot come quickly enough if they are to survive in an environment where UK goods suddenly have a 30% cost advantage. Another reason why an A50 extension is unlikely.

How quickly and thoroughly can the UK implement an import replacement policy? Or is that even in the realm of the conceivable in the UK now. That is the only real protection for a plummeting currency. And such an emphasis on domestic manufacturing will likely be anathema to the 'wealth extraction' parasites in 'The City'?

I think the strategy (insofar as there is one) is to replace EU imports with Commonwealth, Asian or Latin American imports at lower cost. You don't really expect Brits to get their hands dirty and make this stuff themselves, do you? The problems will come when they can no longer pay for these imports after many years of balance of payments deficits and rising consumer debt allied to a Sterling devaluation and credit crunch.

Well, you are referring to the stereotypical upper middle class and upward type of folks. Unless the electorate tires of them and their self serving actions and stays tired until new elections are called there is little that can happen. But, if willing to upset some apple carts, a lot could be done and there are almost certainly lots of Brits willing to do it.

Going full bore import substitution would be the best thing the government could do. Else they could find out why things are so difficult in places like Venezuela. But to get such a program going there would likely have to be a serious reform of the current situation with the popular press.

"you are referring to the stereotypical upper middle class and upward type of folks"

Yes, but fortunately they are the ones in the leadership positions and with the access to the capital and connections required to drive through a transformation of the UK economy.

And it will take more than a transient election loss to Labour to change this: Nothing less than a social revolution which changing the structure of the ruling class in the UK for ever is required.

The nearest parallel I can think of is the WWII years where women entered the workforce, a lot of non-ruling class types achieved positions of leadership, and Brits showed huge ingenuity in overcoming the exigency of war and the loss of raw materials from abroad.

However, with Victory, the UK quickly slipped back into the old ways, with the toffs back in charge, the women put in their place, and the Irish and Commonwealth immigrants doing all the hard work.

The exchange value of GBP floats. The exchange value of GBP is not simply dependent on EU demand for GBP commodity exports PLUS customs duties imposed by "trade partner". There is a big, fat, international universe of currency speculators who sell GBP to extract profit by the pence when trading, say, margin borrowers in securities trading, leveraged CRE purchases, or AG sector swap schemes any given hour of each day. UK has been an international "safe haven" for wealthy investors who'll never buy any UK goods or services but finance. Over the past 30 years UK citizens have been driven into "saving" in the form of RE, draining "real money" in domestic circulation. Economists have attributed 40% of UK income to this industry.

BECAUSE the YoY trend of GBP price is negative, ask: IF demand is directly related to price, where is the "hot money" going instead of the City?

A weaker currency would in normal circumstances mean a boost to exports and an improvement of the trade balance, but in this case rising imports have canceled out the effect.

To what extent do normal circumstances apply anymore? I mean, isn´t there an assumption that what is exported are goods or raw materials made in the exporting country?

I don't know how much of the export looks like that anymore, and there are at least two more cathegories to consider: world-wide production chains and services.

With world-wide production chains I mean the proverbial fish stick that can take a lap around the world before ending on the consumers plate. While currency exchange rates changes costs - here decreasing the cost of UK labour - I don't know how much effect that has in the short term. It all depends on how the production chains are structured. Also access to the next step in the chain is crucial and Brexit is putting that in jeopardy.

And then services, in particular financial services. In general financial services doesn't appear to be very cost sensitive considering the salaries in the sector. Access to markets and financial tricks (legal or otherwise) is probably more important for the bottom line. Also as with other high-end services there is probably an element of considering expensive services to be better - why else would they cost so much? - which would mean that as currency goes down, so does the status of UK fiancial services.

Again, I don't know how large portions these are of UK exports, but I think it should be part of the explanation.

A tangential question is to what extent normal conditions apply to any economy today.

Were 'The City' to be reduced to that size which is required to provide NEEDED financial services in the UK it would likely be less than 10% of its current size. And, in a worst case BREXIT, that might be one result. Many UK financial corporations might collapse, but most international ones would simply relocate most of their current UK assets to the continent.

Such a development would both devastate the upper middle class in the UK and inherently discredit finance in the UK as we know it. There would undoubtedly be knock-on effects on the bottom 90% in the UK which, in absolute terms and in many cases, would be worse than the loss of those in finance - such as collapse of public services and a much larger number of unemployed.

Given the systematic way in which the population has been misled by elites a constructive response to such a crisis seems unlikely. But it remains essential that one be found. The alternatives are very ugly and increasingly probable.

The "worst case" Brexit you outline is the likely outcome if the UK leaves the EEA. Services take up the largest share in the UK's exports and comprise the sector with the highest net positive contribution to the balance of trade. Its demise would not only mean a collapse in high paid labour and taxation, it would open a huge hole in the UK's trade balance and inflate its external debt.

Services take the largest share in the UK's economy and its exports. That is why the widening trade deficit is a bit of a puzzle. Services are not tied to supply chains, in principle there is no need to increase expenses and pass costs on the the client in face of currency devaluation.

Since it is exactly the opposite happening, I wonder if the Services sector has already tied its costs (mostly wages) to other currencies.

I wonder if the fallacy here is to expect the balance of trade to respond too quickly to changes in the exchange rate. I'm no expert in this area, but old habits die hard. If you've always bought a particular brand of whatever you tend to continue buying it unless there is a really sudden, noticeable and major increase in price.

So if the UK is still buying/importing more or less the same goods/service as it did a year ago - and paying up to 18% more for them - you would expect the balance of payments to actually worsen in the short and medium term. Ditto with UK exports, if exporters aren't passing on cost reductions enabled by devaluation or if overseas buyers aren't buying any more of them even if they are cheaper.

In the longer term, of course, you would expect UK exports to increase and imports to reduce, in volume if not in value terms (expressed in Euro). But that also assumes that British exporters are geared up to ramp up production in response to increased demand. Given "goods" as opposed to services are such a small proportion of overall exports, the effect could be quite marginal on the economy as a whole. It will take a very long time before any increase in goods exports makes up for the loss of services exports to the EU when UK institutions lose their passporting rights.

So years from now, "economists" will still be wondering why the UK economy responded so little and so slowly to the devaluation stimulus - much as they wonder now at the continued absence of inflation. None seem to think the UK class structure, the lack of governmental fiscal stimulus or the destruction of Trade Union bargaining power has any role in all of this. Of course we know better!

the issue I see with that is that "balance of payments" is often represented by finished manufactured goods. Things that are bought for a solid price and whose value is accurately reflected within GNP.

Services, especially financial ones, have a much less mechanical relationship to GNP. The money never enters the UK financial sphere, is never taxed here, is never declared here. So, although financial services declare a fabulous value to the nation, the country only benefits from a shadow fraction of this value via wages (but rarely bonuses), and other land subsidies.

The UK is hevily represented in areas that provide no benefit, but has a hollowed out manufacturing base entirely unable to respond to increasingly favourable international trading circumstances

The loss of spending from those employed in the current UK financial system will definitely be felt, just as the closing of a military base is felt. And the >10% of finance that does survive due to actual domestic demand will continue. This is not as bad as, say, the collapse of automobile manufacturing, which would leave the country totally dependent on imports for a basic good. What is important is how much can be made without need for much foreign exchange if the currency continues to be seriously devalued. It could well be that there are business people who were and are quite unhappy with the whole disinvestment parasitism of the financial sector and who will purchase on the cheap existing facilities where UK made goods could now again profitably be made and will start making them again. Ideally this would include new, high tech manufacturing processes such as are being developed around Oxbridge.

As I recall, when we get into the weeds on national accounts, we have the balance of exports minus imports dealing mostly with real goods either raw materials or manufactured goods, and a similar export minus import balance for those services which there can be a direct accounting. But then there is the balance of direct foreign investment into and out of the country along with the flow of revenue streams from those investments. This latter bit is where much of the controversy about Apple, etc. has originated as, under current rules, it can be and has been grossly manipulated. That manipulation is a major part of the core 'competence' of Wall Street and The City.

Context for a future relationship
[...]
In 2016, the EU exported 127.9 billion of consumer goods to the UK and imported 62.3 billion of UK consumer goods. 4 Producers in the rest of the EU rely on UK firms in their supply chains [DISTRIBUTION, RAW GOODS, INTERMEDIATE GOODS, FINISHED GOODS], and vice versa. In addition, the UK is an important contributor to many European value chains [DISTRIBUTION OF 'VALUE-ADDED' BY MECH. & HUMAN LABOR], and in 2011 the UK content accounted for 1.9 per cent of the total value of other EU member state exports, and 6.4 per cent of all foreign value-added [PROFIT MARGIN] in other EU member state exports. 5

Principle D: Where the goods are supplied with services, there should be no restriction to the provision of these services that could undermine the agreement on goods
[...]
34. Goods and services trade flows have consistently moved in lockstep with each other. 11 Services are essential for production of goods, for their sale, distribution and delivery, and for their operation and repair. For example, EU statistics suggest that in 2015 the EU imported 1.6 billion of maintenance and repair services from the UK, while exporting 2.2 billion. 12 As our economies modernise and grow, the link between goods and services is becoming ever more important ...

The pitch is to persuade EU27 to accept cost shifting (again) just in case GBP "breaks" the EUR.

The trend seems relentless. Every day, the Euro appreciates (possibly too much - the Eurozone has its big problems, they just don't make it to the news with so much incompetence on display). The trend since April is just incredible. Markets seem to be pricing in the worst scenario.

Which is not a guaranteed outcome, and indeed faced with a worst case the UK may yet find a way out (EEA, or even second referendum). But a year from now this would not have happened, so it may be the nadir for Sterling, with a guaranteed full catastrophe priced in and maybe an excess in that, as currency depreciations tend to first overshoot (in fact they must, otherwise there would be an opportunity for arbitrage).
And a year from now is when I must leave. School years end in the summer, so it cannot be done before, nor later without risking being after a cliff-edge exit.

At this rate, I am getting quite concerned with how little our savings will be worth in euros when we have to convert them - to have a place to live.

Of course, if the cliff edge happens, then I should start to worry about how much my pension pot will be worth, but that will be a problem for when we are over 55, so less immediate.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

Cyrille, in 2008 when the housing crisis blew up the Euro was at 1.55 to the Dollar; today it is at 1.17. The Euro has been an undervalued currency these past years as the inability to address the sovereign debt crisis and an expectation of a collapse of the EU combined to suppress exchange rates. Now, with European economies back on a growth path and sovereign debt no longer under immediate threat, the Euro has to regain its value - even if partially. Otherwise a large trade surplus would develop, which for an economy this large is not really possible for long.

On a personal note, you should move your savings into another currency as soon as possible. And since you are leaving the UK you should seek to cash in your retirement policy or whatever other retirement instruments you may have. The Sterling is becoming a toxic currency, there is no telling where it can end.

You show the comparison to the dollar - but relative to the pound the euro is now approaching its highest point ever, which was overvalued (and did not last long at all).

So we are not in "partially regaining its value" territory, we are in having got there and looking like it's going to keep moving.

As for our savings they are of three kinds:
-Our flat, which we cannot cash until we find a buyer (and though it is for sale, it is unlikely that it will be sold many months before we can move);
-Our ltd company, which cannot be wound up until after it ceases trading, so even if we were to find a way for my wife to charge differently after she returns from maternity leave, we could not trigger the process before December, and it takes at least 6 months;
-Our pension pots, which by law can no longer be moved to France until we reach 55, which is many (many - I insist ;-) ) years later.

So we are pretty much stuck with Sterling for the time being.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

I've been at it for about four years, casually, meaning posting groups of pair rates at calculatedrisk weekly. I started to do so in rhetorical defense of EUR and RMB for which the nativist' contempt had no bottom known to Anglo-merican business press best practice in exploiting the ignorance of the common "man".

My source was always finance.yahoo! close.

(It kinda sux yahoo! abandoned permalink to pairs, but I really appreciate the site recent re-design from ratio to identity notation. e.g. 1 GBP = x RMB. It was annoying to me to annotate ratio with a sentence, "One pound buys x euros" or "One yuan buys x US dollars.")

In short, USD:EUR has been trading between 0.89 and 0.98 in the period. Low volatility in my book which is "The Purpose of Currency Manipulation by Central Banks is to Eliminate Large Margin Profit Taking Opportunities".

"Markets" are pricing UK third-country status viz. EU. One day after 29 March 2019 the UK gov't will be free to negotiate a bi-lateral treaty with the EU and devalue further value of GBP viz. all other um fungible currencies.

Difficult to consume domestically if you can't produce domestically. In the US we were already short of skilled labor 40 years ago. Then Thatcher shifted the dismantling of the non-FIRE economy, Reagan followed suit, and Blair and Clinton wrapped it up in the 90s.